Financial benchmarking in agriculture gets talked about a lot these days, but can you actually use benchmarking on your own farm to help you meet your profitability or growth objectives?
Start by thinking of financial benchmarking as a farm business report card, the experts say. Like a report card, it will show you where the successes are, and where you can improve.
That’s essentially what benchmarking is all about. It gives you the tools to assess the performance of your farm business against a specific standard of measurement. That standard could be based on your historical data or it could be based on data acquired from statistical data sets, or on all of the above.
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Using a select number of financial ratios (see sidebar), benchmarking lets you compare how your business is performing over a specific time frame and how it measures against other farms in your peer group, based on commodity and geography.
However, the real value in benchmarking isn’t found in the number crunching but in what those numbers show you and, ultimately, what you do with that information. Benchmarking is the diagnosis, not the prescription.
What are the advantages of benchmarking?
betker Financial benchmarking helps provide producers with a form of financial context for analyzing costs. They can compare costs of production and see how their business stacks up against the competition. Then when it comes time to invest, there is a way to see if an investment is warranted. For example, if the financial benchmarks are poor, does it make sense to expand or go through the work of developing an intergeneration plan for succession?
kohl A year-to-year benchmarking allows you to compare yourself to the entire range of producers in your commodity group — the top 20 per cent, the mid-range and the bottom 20 per cent. In our dairy operation, we use the financial ratios to see how our debt level, financial liquidity, financial efficiency, rate of return on assets, and equity measure up.
Often that requires facing the cold, hard facts of reality and accepting the tough news along with the good.
To provide us with that much-needed perspective, we asked two industry veterans from both sides of the border to provide their insights on the advantages of benchmarking in farm business planning.
Based in Winnipeg, Man., Terry Betker is director for agriculture, industry and government at Meyers Norris Penny. David Kohl is emeritus professor of agricultural and applied economics at Virginia Tech. Kohl is also involved in a value-added dairy operation near his home in Blacksburg, VA.
We use it to develop a SWOT (strength, weakness, opportunity and threat) analysis. For example, if a major exporter were to go down, are we threatened because we have low liquidity? The greatest advantage is that it helps you be proactive and plan ahead, particularly in volatile, uncertain markets.
are there draWbacks?
betker Financial benchmarks are a basket of indicators and must be analyzed collectively. There is no one indicator that can suggest a farm has no financial worries any more than there is one that says the farm is financially doomed.
There are other management areas that affect financial performance. For example, a farmer may think there is an operation or production problem when in fact the problem lies in human resources — an employee isn’t carrying his share of the load.
kohl One of the drawbacks is that when
producers get their report card, they find that they are weak in a couple of areas. Don’t be discouraged. There will often be an offsetting strength that will compensate for this. Everyone can’t always be in the top 20 per cent of all areas.
Betker It is critical that producers’ financial record-keeping systems are capable of giving them the information they need. Not having good information at hand can result in a set of inadequate financial benchmarks. The way financial statements are put together and how the information is captured and recorded have a direct impact on benchmarks.
For example, assets may be listed at cost versus market value, statements may be prepared mid-production year, or inventory may be valued with the farmer estimating quantities and values.
It is essential to have consistent, trustworthy information before you even begin the process.
Kohl You have to have solid records that are well put together. Using tax returns in isolation just won’t work because there are often adjustments made to revenue and costs, etc.
What are the next steps?
Betker Once the available data is in good shape, the producer needs to determine what financial indicators or ratios to benchmark. These can be organized into two categories — on a productive unit basis or on a whole-farm business entity basis. An example of a productive unit indicator is the machinery cost per acre (machinery costs divided by the number of acres). The profitability of the business entity can be expressed as a rate of return on assets (net profit divided by the total assets of the farm). From there, check out available benchmark data sites and determine which one is appropriate for their needs.
Kohl All the benchmarking databases in the U. S. use the same 21 ratios. I recommend five to seven ratios that are universal across the sector such as debt levels, return on assets, or liquidity. Once those are established, producers can start to drill down and get more specific to their industry, such as crops, livestock, or dairy.
An excellent source for benchmarking data is the University of Minnesota’s database which has over 25 years of information where you can see the economic cycles of 3,000 farmers over more than two decades. Go to www.finbin.umn.eduand click on Getting Started.
When should you benchmark?
Betker At minimum, it should be done every year at the same time using the same assumptions. Depending on the size and area of financial performance being benchmarked, producers may want to analyze quarterly or semi-annually, especially in the areas of liquidity and cash flow.
Most important, financial benchmarks should include two components. One is benchmarked against their own historic performance and the other against the peer group. A mid-year analysis could be used as an internal trend line analysis, measuring a farm’s performance against itself and looking back at how this July compares to the past five years.
Kohl We do benchmarking every year in our dairy business. Some businesses will do it quarter by quarter and even week by week, if they have businesses that are seasonally intense. For example, a horticulture business that has intense sales in June may see that this year’s sales aren’t as brisk, so they can make adjustments to strategies right then. That is really the benefit of benchmarking — you can customize it so it fits your specific business and industry.
Should you work with a financial adviser?
Betker Yes, I recommend it. Here’s why. Interpretation of the information is essential. Does the farmer have that expertise? Can he or she make management decisions based on the results and place the benchmark information into the right context? I’m regularly involved in discussions with farmers who understand the ratios and indicators and can see the changes on their farms year to year. But when it comes down to putting that information to work in making management decisions and investment, this is an area where they could use the assistance of an objective third party like a financial adviser, management consultant or accountant.
Kohl Benchmarking only identifies the symptoms so you really do need another set of eyes to help you see where you are going. I’ve been in this business for 35 years and I still use an adviser for our farm business because sometimes you can get so emotionally tied up in the business, you can’t see the forest for the trees. You need someone who might see things you just can’t.
Is benchmarking worth the investment of time?
The final word goes to Kohl: Yes, but you have to be emotionally secure and not take it personally. Let the numbers challenge you and don’t give up. CG
Ron Wall is a communications specialist and prepared this article for Country Guide on behalf of the Canadian Farm Business Management Council (www.farmcentre.com).Funded mainly by the federal government, CFBMC’s role is to foster and support cutting-edge business practices on Canadian farms.
